ECONOMIC CRISIS OF SRILANKA

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Context: India has lent over $2.5 billion in credit so far, in addition to $500 million for a shipment of diesel.

Sri Lanka economic crisis:

Sri Lanka faces its worst economic crisis in decades. People are now fleeing Sri Lanka and trying to enter India.
The Mahinda Rajapaksa government is struggling to pay for essential imports after a 70 per cent drop in foreign exchange reserves over two years triggered a currency devaluation.
Fuel is in short supply, prices of food and essential goods have increased and protests have broken out as the government preps for talks with the International Monetary Fund amid concerns over its ability to pay $4 billion in foreign debts this year, including a $1 billion international sovereign bond that matures in July.

Background:

It is an outcome of poor public-finance management, bad policymaking and a pandemic.
Sri Lankan President Gotabaya Rajapaksa's government in 2019 announced a massive tax cut that cost the country losses of more than 2 per cent of its GDP.

What is happening in Sri Lanka?

It is deep in debt. Its public debt is estimated to be 119 percent of the GDP.
It means that it has borrowed more than it can produce.
Sri Lanka runs out of diesel, faces longest-ever blackout.
Sri Lanka has borrowed heavily from foreign markets. The largest slice of the borrowing has been done in international sovereign bonds, which is 36.4 percent of all the foreign debt. Its second-largest lender is the Asian Development Bank (ADB), which gave 14.6 percent of the total. Then Japan and China, which gave 10.9 and 10.8 percent, respectively.
India have lent $1.4 billion, which is about a third of what Japan or China has done. Sri Lanka has asked for $1 billion more.
India has also extended a $400 million currency swap and deferred payment of $515.2 million to the Asian Clearing Union (ACU) by two months.
In 2021, the PM promoted organic farming by banning the import and use of chemical fertilisers and pesticides. It led to panic about shortages and food prices rocketed. But six months later government revoked the ban and announced $200 million in compensation to rice farmers who had to take losses because of the ban.

What does the IMF advise?

To protect the vulnerable and the poor through policy: creating fiscal space for higher social safety net spending, the coverage, targeting, and per-family benefit needs to be strengthened to provide adequate protection for vulnerable groups.
To improve revenue generation and collection: Fiscal consolidation should be primarily revenue-based, given Sri Lanka’s very low tax-to-GDP ratio. The needed revenue should be mobilized by raising rates, minimizing exemptions, and ensuring greater contributions from high-income earners.

India’s Four-pillar initiative for Sri Lanka:

It comprising lines of credit for food, medicines and fuel purchases granted by India
A currency swap agreement to deal with Sri lanka’s balance of payment issues
An “early” modernisation project of the Trinco oil farms that India has been pursuing for several years, and
A Sri Lankan commitment to facilitate Indian investments in various sectors.